UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________________ to _________________
NORTHEAST PENNSYLVANIA FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 06-1504091
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
12 E. BROAD STREET, HAZLETON, PENNSYLVANIA 18201
(Address of principal executive offices) (Zip Code)
(570) 459-3700
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
--------- -------
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes No X
--------- -------
The Registrant had 4,176,593 shares of Common Stock outstanding as of August 19, 2003.
Item
No.
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Page
Number
PART I - CONSOLIDATED FINANCIAL INFORMATION
Item 1 CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition at
June 30, 2003 and September 30, 2002 (unaudited)................................ 1
Consolidated Statements of Operations for the Three and Nine Months
Ended June 30, 2003 and 2002 (unaudited)........................................ 2
Consolidated Statements of Comprehensive Income for the Three and Nine
Months Ended June 30, 2003 and 2002 (unaudited)................................. 3
Consolidated Statements of Cash Flows for the Nine Months Ended
June 30, 2003 and 2002 (unaudited).............................................. 4
Notes to Consolidated Financial Statements (unaudited).......................... 6
Item 2 Management Discussion and Analysis of Financial Condition
and Results of Operations.......................................................20
Item 3 Quantitative and Qualitative Disclosures about Market Risk......................27
Item 4 Controls and Procedures.........................................................27
Part II - OTHER INFORMATION
Item 1 Legal Proceedings...............................................................28
Item 2 Changes in Securities and Use of Proceeds.......................................28
Item 3 Defaults Upon Senior Securities.................................................28
Item 4 Submission of Matters to a Vote of Security Holders.............................28
Item 5 Other Information...............................................................28
Item 6 Exhibits and Reports on Form 8 - K..............................................28
Signatures
As Restated 1
June 30, September 30,
2003 2002
--------------------- -----------------
---------------------------------------------
(in thousands)
ASSETS
Cash and cash equivalents $ 38,740 $ 25,302
Securities available-for-sale 295,980 327,886
Securities held-to-maturity (estimated fair
market value of $3,624 at June 30, 2003
and $3,707 at September 30, 2002) 3,555 3,652
Loans (less allowance for loan loss of
$5,748 at June 30, 2003 and $5,449 at
September 30, 2002) 493,930 489,186
Accrued interest receivable 3,792 4,298
Assets acquired through foreclosure 641 547
Property and equipment, net 12,622 12,840
Goodwill 3,655 3,655
Intangible assets 8,804 9,093
Bank-owned life insurance 10,749 10,303
Other assets 13,318 15,850
--------------------- -----------------
TOTAL ASSETS $ 885,786 $ 902,612
===================== =================
LIABILITIES
Deposits $ 578,765 $ 606,412
Federal Home Loan Bank advances 208,406 208,421
Other borrowings 1,061 3,184
Trust-preferred debt 22,000 7,000
Advances from borrowers for taxes and
insurance 1,639 852
Accrued interest payable 1,557 1,458
Other liabilities 7,896 9,591
--------------------- -----------------
TOTAL LIABILITIES 821,324 836,918
--------------------- -----------------
STOCKHOLDERS' EQUITY
Preferred stock ($.01 par value; 2,000,000
authorized shares; 0 shares)
Common stock, $.01 par value; 16,000,000
Shares authorized, 6,427,350 shares issued 64 64
Additional paid-in capital 61,956 62,047
Retained earnings - substantially restricted 35,155 35,981
Accumulated other comprehensive income, net 2,937 3,443
Common stock acquired by stock benefit plans (4,738) (4,156)
Treasury stock, at cost (2,250,757 shares at
June 30, 2003 and 2,256,526 shares at
September 30, 2002) (30,912) (31,685)
--------------------- -----------------
TOTAL STOCKHOLDERS' EQUITY 64,462 65,694
--------------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $ 885,786 $ 902,612
===================== =================
See accompanying notes to the unaudited consolidated financial statements.
1 See Footnote 2 which describes the restatement effects.
Three Months Ended Nine Months Ended
June 30, June 30,
As Restated 1 As Restated 1
2003 2002 2003 2002
(in thousands, except per share data)
INTEREST INCOME
Interest and fees on loans $ 8,165 $ 9,356 $ 25,297 $ 28,631
Mortgage-related securities 1,512 2,232 5,193 6,261
Investment securities:
Taxable 1,166 1,346 3,620 4,404
Tax-exempt 233 236 700 711
-------- -------- --------- ----------
Total interest income 11,076 13,170 34,810 40,007
-------- -------- --------- ----------
INTEREST EXPENSE
Deposits 2,870 4,148 9,790 12,802
Federal Home Loan Bank advances and
other borrowings 2,978 2,990 8,934 8,835
Trust-preferred debt 267 96 784 96
-------- -------- --------- ----------
Total interest expense 6,115 7,234 19,508 21,733
-------- -------- --------- ----------
NET INTEREST INCOME 4,961 5,936 15,302 18,274
Provision for loan losses 850 726 1,830 1,969
-------- -------- --------- ----------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 4,111 5,210 13,472 16,305
-------- -------- --------- ----------
NON-INTEREST INCOME
Service charges and other fees 684 499 1,958 1,502
Insurance premium income 1,084 822 2,911 2,264
Trust income 215 167 660 515
Gain (loss) on sale of:
Assets acquired through foreclosure 70 (10) 129 (30)
Loans 562 509 1,165 748
Available-for-sale securities 237 4 1,379 (7)
Impairment loss on equity investment (1,488) - (1,488) -
Other 350 244 1,346 430
-------- -------- --------- ----------
Total non-interest income 1,714 2,235 8,060 5,422
-------- -------- --------- ----------
NON-INTEREST EXPENSE
Salaries and employee benefits 3,486 2,994 9,962 8,814
Occupancy costs 797 752 2,453 2,169
Amortization of intangibles 255 296 772 809
Data processing costs 200 182 579 514
Advertising 255 165 783 438
Professional fees 345 434 1,321 1,129
Federal Home Loan Bank and other charges 240 260 702 742
Other 1,226 920 3,349 2,485
-------- -------- --------- ----------
Total non-interest expense 6,804 6,003 19,921 17,100
-------- -------- --------- ----------
Income (loss) before income taxes (979) 1,442 1,611 4,627
Income taxes 125 498 967 1,612
NET INCOME (LOSS) $ (1,104) $ 944 $ 644 $ 3,015
======== ======== ========= ==========
EARNINGS (LOSS) PER SHARE:
Basic $ (0.29) $ 0.23 $ 0.17 $ 0.73
Diluted (0.28) 0.22 0.16 0.69
See accompanying notes to the unaudited consolidated financial statements.
1 See Footnote 2 which describes the restatement effects.
Three Months Ended Nine Months Ended
June 30, June 30,
As As
Restated 1 Restated 1
2003 2002 2003 2002
--------------- ------------- ------------ ------------
(in thousands)
Net income (loss) $ (1,104) $ 944 $ 644 $ 3,015
Other comprehensive income (loss), net of tax
Unrealized losses on securities and on retained
interest on asset securitization:
Unrealized holding gains (losses) arising during the
period 1,537 3,090 (1,352) 756
Less: Reclassification adjustment for gains (losses)
included in net income 145 3 846 (5)
--------------- ------------- ------------ ------------
Other comprehensive income (loss) 1,392 3,087 (506) 761
--------------- ------------- ------------ ------------
Comprehensive income (loss) $ 288 $ 4,031 $ 138 $ 3,776
=============== ============= ============ ============
See accompanying notes to the unaudited consolidated financial statements.
1 See Footnote 2 which describes the restatement effects.
Nine Months Ended
As Restated 1
June 30, June 30,
2003 2002
--------------- ----------------
OPERATING ACTIVITIES
Net income $ 644 $ 3,015
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses 1,830 1,969
Provision for assets acquired
through foreclosure 208 90
Depreciation 1,063 1,079
Amortization of intangibles 772 809
Deferred income taxes (1,597) 3,325
ESOP expense 580 619
Stock award expense 392 373
Bank-owned life insurance income (446) (149)
Amortization and accretion on:
Held to maturity securities (1) (9)
Available for sale securities 4,651 519
Amortization of deferred loan fees (724) (439)
(Gain) loss on sale of:
Assets acquired through foreclosure (129) 30
Loans (1,165) (1,195)
Available for sale securities (1,379) 7
Disposal of fixed assets 19 -
Changes in assets and liabilities:
Decrease in accrued interest receivable 506 297
Increase in other assets (136) (5,432)
Increase in accrued interest payable 99 479
Increase (decrease) in accrued taxes payable 2,185 (2,072)
Increase in other liabilities 440 1,289
--------------- ----------------
Net cash provided by operating activities 7,812 4,604
--------------- ----------------
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from repayments and maturities 128,727 53,484
Purchases (193,289) (160,628)
Proceeds from sales 93,193 16,837
Investment securities held to maturity:
Proceeds from repayments and maturities 98 14,199
Increase in loans, net (40,656) (40,461)
Proceeds from sales of loans 35,105 62,073
Purchase of regulatory stock (1,041) (450)
Purchase of premises and equipment (864) (1,677)
Proceeds from assets acquired through foreclosure 693 775
Purchase of bank-owned life insurance - (10,000)
--------------- ----------------
Net cash provided for (used for) investing activities $ 21,966 $ (65,848)
--------------- ----------------
Nine Months Ended
June 30,
As Restated 1
2003 2002
---------- ----------
FINANCING ACTIVITIES
Net increase (decrease ) in deposits $ (27,647) $ 56,312
Decrease in Federal Home Loan Bank
short-term advances - (6,000)
Borrowings of Federal Home Loan Bank
long-term advances - 10,000
Repayments of Federal Home Loan Bank
long-term advances (15) (15)
Net increase in advances from borrowers for
taxes and insurance 787 727
Proceeds from other borrowings 1,599
Repayment of other borrowings (2,123) -
Proceeds from issuance of trust-preferred securities 15,000 7,000
Purchase of treasury stock - (9,087)
Purchase of stock for stock employee
compensation trust (1,110) -
Stock issued for purchase of
Higgins Insurance Associates, Inc. 100 85
Exercise of stock options 138 477
Cash dividends (1,470) (1,461)
---------- ----------
Net cash provided by (used in) financing activities (16,340) 59,637
---------- ----------
Increase (decrease) in cash
and cash equivalents 13,438 (1,607)
CASH AND CASH EQUIVALENTS
AT BEGINNING OF YEAR 25,302 9,060
---------- ----------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 38,740 $ 7,453
========== ==========
SUPPLEMENTAL INFORMATION
Cash paid during the year for:
Interest on deposits and borrowings $ 19,409 $ 21,254
Income taxes 1,749 482
Supplemental disclosures - non-cash and financing information:
Transfer from loans to assets acquired
through foreclosure 866 1847
Net change in unrealized gains on securities
available for sale, net of tax (506) 761
1See Footnote 2 which describes restatement effects.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Northeast Pennsylvania Financial Corp. (the “Company”), through its subsidiaries, provides a wide range of financial products and services to individual, corporate, and municipal customers through offices in Northeastern and Central Pennsylvania. These products include Banking, Insurance, Investment and Trust lines of business. Banking products, which are offered through the Company’s subsidiary, First Federal Bank (the “Bank”), include checking accounts (interest and non-interest bearing), savings accounts, certificates of deposit, commercial and consumer loans, real estate loans and home equity loans. The Bank also serves its loan customers through a loan production office located in Monroe County, Pennsylvania. Insurance products, which are offered through the Company’s subsidiary, Higgins Insurance Associates, Inc. (“Higgins”), include property and casualty, life, long-term care and employee benefit programs. Investment products are offered through licensed Bank employees, Higgins agents and Smith Barney financial consultants who rent space from the Bank. Trust services, which are offered by the Company’s subsidiary Northeast Pennsylvania Trust Co. (the “Trust Co.”), include estate management and trustee services. The Company also provides title insurance through Abstractors, Inc., its wholly-owned title agency. The Company and the Bank are subject to the regulations of certain federal regulatory agencies and undergoes periodic examinations by such regulatory authorities. The Trust Co. is subject to state regulation.
Basis of Financial Statements Presentation
The accompanying consolidated financial statements were prepared in accordance with instructions to Form 10-Q, and therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (“GAAP”). However, all normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the financial statements have been included. The results for the nine months ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ended September 30, 2003.
Principles of Consolidation and Presentation
The accompanying financial statements of the Company include the accounts of the Bank, Higgins, Abstractors, Inc., Trust Co., FIDACO, Inc., NEP Capital Trust I and NEP Capital Trust II. The Bank, Higgins, Abstractors, Inc. and the Trust Co. are wholly-owned subsidiaries of the Company. NEP Capital Trust I and NEP Capital Trust II are statutory trusts all of the voting securities of which are owned by the Company, which were created under the laws of the state of Delaware in connection with two issuances of trust-preferred securities on April 10 and October 29, 2002, respectively. All material inter-company balances and transactions have been eliminated in consolidation. Prior period amounts are reclassified, when necessary, to conform with the current year’s presentation.
The Company follows accounting principles and reporting practices which are in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses, the evaluation of the realizability of deferred tax assets and the evaluation of other than temporary impairment for certain non-marketable equity investments and residual interests in the securitization trusts.
Recent Accounting Developments
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).“The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of this Statement did not have an impact on its earnings, financial condition or equity.
On October 1, 2002, the FASB issued SFAS No. 147, “Acquisitions of Certain Financial Institutions,” effective for all business combinations initiated after October 1, 2002. This Statement addresses the financial accounting and reporting for the acquisition of all or part of a financial institution, except for a transaction between two or more mutual enterprises. This Statement removes acquisitions of financial institutions, other than transactions between two or more mutual enterprises, from the scope of SFAS No. 72, “Accounting for Certain Acquisitions of Banking or Thrift Institutions,” and FASB Interpretation No. 9, “Applying APB
Opinions No. 16 and 17,"When a Savings and Loan Association or a Similar Institution Is Acquired in a Business Combination Accounted for by the Purchase Method.” The acquisition of all or part of a financial institution that meets the definition of a business combination shall be accounted for by the purchase method in accordance with SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 was adopted on October 1, 2001. This Statement also provides guidance on the accounting for the impairment or disposal of acquired long-term customer-relationship intangible assets (such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets), including those acquired in transactions between two or more mutual enterprises. Upon early adoption of this statement, as of October 1, 2001, the carrying amount of the previously recognized unidentifiable intangible asset related to the Schuylkill Savings branch acquisitions that was reclassified to goodwill was $200,000, while the related 2002 amortization expense that was reversed was $81,000, pre-tax. The Company will continue to review the remaining goodwill on an annual basis for impairment. However, $10.9 million in core deposit intangible will continue to be amortized and reviewed for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
In December 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123.” This statement amends FASB Statement No.123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Statement also amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement is effective for fiscal years ending after December 15, 2002, except for financial reports containing condensed financial statements for interim periods for which disclosure is effective for periods beginning after December 15, 2002. This Statement announces, “in the near future, the Board plans to consider whether it should propose changes to the U.S. standards on accounting for stock-based compensation."
As permitted, the Company continues to account for stock options with the methodology prescribed by Accounting Principles Board Opinion No. 25. The following table represents the effect on net income and earnings per share had the Company applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation:
Three Months Ended June 30, Nine Months Ended June 30,
As Restated 1 As Restated 1
2003 2002 2003 2002
----------------- ----------------- ----------------- -----------------
(Dollars in thousands, except per share data)
Net income (loss), as reported: $ (1,104) $ 944 $ 644 $ 3,015
Less: proforma expense related
to stock options
(44) - (239) (218)
----------------- ----------------- ----------------- -----------------
Proforma net income (loss) (1,148) 944 405 2,797
================= ================= ================= =================
Basic net income (loss) per common share:
As reported $ (0.29) $ 0.23 $ 0.17 $ 0.73
Pro forma (0.31) 0.23 0.11 0.67
Diluted net income (loss) per common share:
As reported $ (0.28) $ 0.22 $ 0.16 $ 0.69
Pro forma (0.29) 0.22 0.10 0.64
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The amendments set forth in SFAS No. 149 require that contracts with comparable characteristics be accounted for similarly. In particular, this statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative as discussed in SFAS No. 133. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 amends certain other existing pronouncements. Those changes will result in more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant separate accounting. This statement is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. The guidance should be applied prospectively. The provisions of this statement
that relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to existing contracts as well as new contracts entered into after June 30, 2003. The adoption of this statement is not expected to have a material effect on the Company’s financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes how an issuer classifies financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify these financial instruments as a liability (or, in certain circumstances, an asset). Previously these financial instruments would have been classified entirely as equity, or between the liabilities section and equity section of the statement of financial condition. This Statement also addresses questions about the classification of certain financial instruments that embody obligations to issue equity shares. The provisions of this Statement are effective for interim periods beginning after June 15, 2003. Management does not expect the adoption of this statement to have an impact on the Company’s consolidated earnings, financial condition, or equity.
In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. This interpretation clarifies that a guarantor is required to disclose (a) the nature of the guarantee, including the approximate term of the guarantee, how the guarantee arose, and the events or circumstances that would require the guarantor to perform under the guarantee; (b) the maximum potential amount of future payments under the guarantee; (c) the carrying amount of the liability, if any, for the guarantor’s obligations under the guarantee; and (d) the nature and extent of any recourse provisions or available collateral that would enable the guarantor to recover the amounts paid under the guarantee. This interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the obligations it has undertaken in issuing the guarantee, including its ongoing obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. The objective of the initial measurement of that liability is the fair value of the guarantee at its inception. The initial recognition and initial measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements in this interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of this interpretation did not have a material effect on the Company’s financial position or results of operations.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” (FIN 46) in an effort to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. The objective of this interpretation is not to restrict the use of variable interest entities but to improve financial reporting by companies involved with variable interest entities. Until now, one company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. This interpretation changes that by requiring a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of this interpretation apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The adaption of the interpretation did not have a material effect on the Compnay's financial position of results of operations.
2. EFFECTS OF RESTATEMENT
The consolidated financial statements as presented for the three and nine month periods ended June 30, 2002 and the consolidated statement of financial condition at September 30, 2002 have been restated to reflect the correction of accounting errors for the Company’s indirect auto, mortgage and consumer loan portfolios. Such errors were primarily the result of computer coding errors and do not impact any loan customers and had no affect on the Company’s cash flow. These errors were identified during July 2003 and reduced the Company’s stockholders’ equity and aggregate net earnings as follows for the periods presented:
Three months ended Nine months ended
June 30, 2002 June 30, 2002
-------------------- --------------------
(in thousands, except per share data)
Net income prior to restatement $1,551 $4,059
Adjustment for interest and fees on loans, net of tax benefit (318) (755)
Adjustment for gain on sale of loans, net of tax benefit (289) (289)
----- -----
Net income, as adjusted $ 944 $3,015
======= ========
Earnings Per Share (EPS)
Basic EPS prior to restatement $ 0.39 $ 0.98
Adjustment for interest and fees on loans, net of tax benefit (0.08) (0.18)
Adjustment for gain on sale of loans, net of tax benefit (0.07) (0.07)
----- -----
Basic EPS, as adjusted, net of tax benefit $ 0.24 $ 0.73
========= =========
Diluted EPS prior to restatement $ 0.36 $ 0.93
Adjustment for interest and fees on loans, net of tax benefit (0.07) (0.17)
Adjustment for gain on sale of loans, net of tax benefit (0.07) (0.07)
-------- ---------
Diluted EPS, as adjusted, net of tax benefit $ 0.22 $ 0.69
======== =========
At September 30, 2002
---------------------
Stockholders' Equity, prior to restatement $68,385
Cumulative effect of interest and fees on loans, net of tax benefit (2,487)
Cumulative effect of gain on sale of loans, net of tax benefit (204)
----------
Stockholders' Equity, as adjusted $65,694
========
In addition to the items above, the Company’s Consolidated Statement of Financial Condition for September 30, 2002 contained the following restatements and reclassifications:
Balance Balance
As Restated As Reported
September 30, 2002 Change Description
---------------------------------- ------ ------------------
(in thousands)
Assets
- ------
Loans, net of allowance for loan loss $489,186 $489,373 $ (187) Carrying value adjusted to reflect
changes in amortization of premiums
for purchased consumer and mortgage loans
Accrued interest receivable 4,298 7,632 (3,334) Correction of error on indirect autos
Other assets 15,850 7,759 8,091 Reclassification for accrued/deferred taxes
of $8,713 and the tax effect of correction of errors of ($622)
Deposits $606,412 $604,966 $1,446 Reclassification of borrowing/deposits
Other borrowings 3,184 4,630 (1,446) Reclassification of deposits/borrowings
Other liabilities 9,591 2,330 7,261 Reclassification for accrued taxes of $5,909 and the tax effect
of correction of errors of $1,352
Retained earnings-substantially restricted 35,981 38,672 (2,691) Net adjustments to earnings for correction
of errors
The following table describes the effects of the restatement on net income and earnings per share for each of the prior fiscal years:
Twelve months ended Twelve months ended Twelve months ended Twelve months ended Year ended
September 30, 2002 September 30, 2001 September 30, 2000 September 30, 1999 September 30, 1998
Net income prior to restatement 4,498 4,807 3,936 4,565 (47)
Adjustment for interest and fees on loans, net (1,029) (605) (389) (321) (142)
of tax benefit
Adjustment for gain on sale of loans, net of
tax benefit (204) - - - -
------- ------- ------- ------- -------
NET INCOME, AS ADJUSTED 3,265 4,202 3,547 4,244 (189)
======= ======= ======= ======= =======
EARNINGS PER SHARE (EPS)
Basic EPS prior to restatement 1.11 1.03 0.84 0.84 (.20)
Adjustment for interest and fees on loans,
net of tax benefit (0.25) (0.13) (0.08) (0.06) (0.02)
Adjustment for gain on sale of loans, net
of tax benefit (0.05) - - - -
------- ------- ------- ------- -------
Basic EPS, as adjusted, net of tax benefit 0.81 0.90 0.76 0.78 (0.22)
======= ======= ======= ======= =======
Diluted EPS prior to restatement 1.05 1.02 0.81 0.80 (0.20)
Adjustment for interest and fees on loans,
net of tax benefit (0.24) (0.13) (0.08) (0.06) (0.02)
Adjustment for gain on sale of loans, net of
tax benefit (0.04) - - - -
------- ------- ------- ------- -------
Diluted EPS, as adjusted, net of tax benefit 0.77 0.89 0.73 0.74 (0.22)
======= ======= ======= ======= =======
The following table describes the effects of the restatement on net income, earnings per share and stockholders' equity for each of the prior quarters, where material.
Three months Three months Three months Three months Three months Three months Three months Three months Three months Three months Three months Three months Three months Three months
ended ended ended ended ended ended ended ended ended ended ended ended ended ended
March 31, December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, December 31,
2003 2002 2002 2002 2002 2001 2001 2001 2001 2000 2000 2000 2000 1999
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net Income prior to
restatement 1,289 943 439 1,551 1,230 1,278 1,237 1,256 1,023 1,291 515 1,176 1,099 1,146
Adustment for interest and
fees on loans, net of tax benefit (302) (293) (274) (318) (226) (211) (180) (160) (135) (130) (117) (99) (92) (81)
Adjustment for gain on sale
of loans, net of tax benefit 44 66 85 (289) - - - - - - - - - -
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
NET INCOME, AS ADJUSTED 1,031 716 250 944 1,004 1,067 1,057 1,096 888 1,161 398 1,077 1,007 1,065
========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ==========
EARNINGS PER SHARE (EPS)
Basic EPS prior to restatement 0.34 0.25 0.12 0.39 0.31 0.29 0.27 0.27 0.21 0.28 0.11 0.25 0.23 0.22
Adjustment for interest and fees on
loans, net of tax benefit (0.08) (0.08) (0.08) (0.08) (0.06) (0.05) (0.04) (0.03) (0.03) (0.03) (0.03) (0.02) (0.02) (0.01)
Adjustment for gain on sale of loans,
net of tax benefit 0.01 0.02 0.02 (0.07) - - - - - - - - - -
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Basic EPS, as adjusted, net
of tax benefit 0.27 0.19 0.06 0.24 0.25 0.24 0.23 0.24 0.18 0.25 0.08 0.23 0.21 0.21
========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ==========
Diluted EPS prior to restatement 0.33 0.24 0.11 0.36 0.29 0.28 0.26 0.26 0.21 0.27 0.11 0.24 0.22 0.22
Adjustment for interest and fees on
loans, net of tax benefit (0.08) (0.07) (0.07) (0.07) (0.05) (0.05) (0.04) (0.03) (0.03) (0.03) (0.03) (0.02) (0.02) (0.02)
Adjustment for gain on sale of loans,
net of tax benefit 0.01 0.01 0.01 (0.07) - - - - - - - - - -
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Diluted EPS, as adjusted,
net of tax benefit 0.26 0.18 0.05 0.22 0.24 0.23 0.22 0.23 0.18 0.24 0.08 0.22 0.20 0.20
========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ========== ==========
At March 31, At December At September At June 30, At March 31, At December At September At June At March At December At September At June At March At December
2003 31, 2002 30, 2002 2002 2002 31, 2001 30, 2001 30, 2001 31, 2001 31, 2000 30, 2000 30, 2000 31, 2000 31, 1999
Stockholders' Equity, prior to restatement $ 67,326 $ 68,320 $ 68,385 $ 71,663 $ 67,258 $ 74,204 $ 75,837 $ 74,701 $ 78,675 $ 73,769 $ 72,975 $ 71,105 $ 71,535 $ 72,893
Cumulative effect of interest and fees
on loans, net of tax benefit (3,081) (2,779) (2,487) (2,212) (1,894) (1,668) (1,457) (1,277) (1,117) (982) (852) (735) (636) (544)
Cumulative effect of gain on sale of
loans, net of tax benefit (94) (138) (204) (289) - - - - - - - - - -
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY, AS ADJUSTED $ 64,151 $ 65,403 $ 65,694 $ 69,162 $ 65,364 $ 72,536 $ 74,380 $ 73,424 $ 77,558 $ 72,787 $ 72,123 $ 70,370 $ 70,899 $ 72,349
===========================================================================================================================================================================================================
The Company expects to submit an amended Form 10-K for the fiscal year ended September 30, 2002 and amended Forms 10-Q for the December 2002 and March 2003 quarters as soon as practical.
3. EARNINGS (LOSS) PER SHARE
Earnings (loss) per share (“EPS”), basic and diluted, were $(0.29) and $(0.28), respectively, for the three months ended June 30, 2003 compared to $0.23 and $0.22, respectively, for the three months ended June 30, 2002. EPS, basic and diluted, were $0.17 and $0.16, respectively, for the nine months ended June 30, 2003 compared to $0.73 and $0.69, respectively, for the nine months ended June 30, 2002.
The following table presents the reconciliation of the numerators and denominators of the basic and diluted EPS computations.
Three Months Ended Nine Months Ended
June 30, June 30,
As Restated 1 As Restated 1
2003 2002 2003 2002
---------------- ---------------- ---------------- ----------------
(Dollars in thousands, except per share data)
Net income (loss) $ (1,104) $ 944 $ 644 $ 3,015
================ ================ ================ ================
Weighted-average common shares
outstanding 6,427,350 6,427,350 6,427,350 6,427,350
Average treasury stock shares (2,250,756) (1,998,188) (2,253,695) (1,851,705)
Average common stock acquired by stock benefit plans:
Stock employee compensation trust (108,769) (6,259) (87,499) (6,259)
Stock awards unallocated, net (75,636) (117,414) (75,636) (117,814)
ESOP shares unallocated, net (237,808) (289,228) (250,663) (302,083)
---------------- ---------------- ---------------- ----------------
Weighted-average common shares used
to calculate basic earnings per share 3,754,381 4,016,261 3,759,857 4,149,489
Dilutive effect of stock awards 9,777 26,084 11,317 26,366
Dilutive effect of outstanding
stock options 169,977 213,385 169,977 202,786
---------------- ---------------- ---------------- ----------------
Weighted-average common shares used
to calculate diluted earnings per share 3,934,135 4,255,730 3,941,151 4,378,641
================ ================ ================ ================
Earnings (loss) per share-basic $ (0.29) $ 0.23 $ 0.17 $ 0.73
Earnings (loss) per share-diluted $ (0.28) $ 0.22 $ 0.16 $ 0.69
Diluted earnings (loss) per share include the dilutive effect of the Company’s weighted-average stock options/awards outstanding using the Treasury Stock method. The Company had anti-dilutive common stock options outstanding of 10,485 and 8,100 for the three months ended June 30, 2003 and 2002, repectively, and 10,485 and 9,650 for the nine months ended June 30, 2003 and 2002, respectively. These options are not included in the calculation of diluted earnings per share for the periods presented.
4. INVESTMENT SECURITIES
The amortized cost and estimated market values of investment securities are summarized as follows:
June 30, 2003
---------------------------------------------------------------------------
---------------------------------------------------------------------------
(in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Available-for-sale securities: Cost Gains Losses Value
----------------- ----------------- ----------------- -----------------
----------------- ----------------- ----------------- -----------------
U.S. Government agency
securities $ 28,186 $ 489 $ - $ 28,675
Municipal securities 14,981 240 - 15,221
Corporate securities 38,899 2,109 - 41,008
Trust Preferred securities 12,762 674 (389) 13,047
Mortgage-backed securities 176,398 1,910 (265) 178,043
----------------- ----------------- ----------------- -----------------
Total debt securities 271,226 5,422 (654) 275,994
----------------- ----------------- ----------------- -----------------
FHLB Stock
11,693 - - 11,693
Freddie Mac stock 2,241 134 (580) 1,795
Fannie Mae stock 6,000 189 (65) 6,124
Other equity securities 284 148 (58) 374
----------------- ----------------- ----------------- -----------------
Total equity securities 20,218 471 (703) 19,986
----------------- ----------------- ----------------- -----------------
Total $ 291,444 $ 5,893 $ (1,357) $ 295,980
================= ================= ================= =================
June 30, 2003
---------------------------------------------------------------------------
---------------------------------------------------------------------------
(in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Held-to-maturity securities: Cost Gains Losses Value
----------------- ----------------- ----------------- -----------------
----------------- ----------------- ----------------- -----------------
Municipal securities $ 3,555 $ 69 $ - $ 3,624
----------------- ----------------- ----------------- -----------------
Total $ 3,555 $ 69 $ - $ 3,624
================= ================= ================= =================
September 30, 2002
---------------------------------------------------------------------------
(in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Available-for-sale securities: Cost Gains Losses Value
----------------- ----------------- ----------------- -----------------
----------------- ----------------- ----------------- -----------------
U.S. Government agency
securities $ 24,032 414 - 24,446
Municipal securities 16,247 197 - 16,444
Corporate securities 32,545 1,442 (18) 33,969
Trust Preferred securities 12,604 336 (511) 12,429
Mortgage-backed securities 221,383 4,047 (143) 225,287
----------------- ----------------- ----------------- -----------------
Total debt securities 306,811 6,436 (672) 312,575
----------------- ----------------- ----------------- -----------------
FHLB Stock 10,971 - - 10,971
Freddie Mac stock 2,241 151 (324) 2,068
Fannie Mae stock 2,000 100 (108) 1,992
Other equity securities 284 24 (28) 280
----------------- ----------------- ----------------- -----------------
Total equity securities 15,496 275 (460) 15,311
----------------- ----------------- ----------------- -----------------
Total $ 322,307 $ 6,711 $ (1,132) $ 327,886
================= ================= ================= =================
September 30, 2002
---------------------------------------------------------------------------
---------------------------------------------------------------------------
(in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Held-to-maturity securities: Cost Gains Losses Value
----------------- ----------------- ----------------- -----------------
----------------- ----------------- ----------------- -----------------
Municipal securities $ 3,553 $ 55 $ - $ 3,608
Certificates of deposit 99 - - 99
----------------- ----------------- ----------------- -----------------
Total $ 3,652 $ 55 $ - $ 3,707
================= ================= ================= =================
5. LOANS
Loans consists of the following:
As Restated
June 30, September 30,
2003 2002
----------------- -----------------
------------------------------------
(in thousands)
Real Estate Loans:
One-to four-family $ 159,354 $ 198,225
Multi-family and commercial 71,009 75,912
Construction 17,275 7,157
----------------- -----------------
Total real estate loans 247,638 281,294
----------------- -----------------
Consumer Loans:
Home equity loans and lines of credit 74,760 79,167
Automobile 122,315 80,016
Unsecured lines of credit 3,073 2,297
Other 9,572 10,376
----------------- -----------------
Total consumer loans 209,720 171,856
----------------- -----------------
Commercial Loans 43,895 43,014
----------------- -----------------
Total loans 501,253 496,164
Less:
Deferred loan fees, net 1,575 1,529
Allowance for loan losses 5,748 5,449
----------------- -----------------
Net loans $ 493,930 $ 489,186
================= =================
The activity in the allowance for loan losses is as follows (in thousands):
Nine Months Nine Months
Ended Year Ended Ended
June 30, September 30, June 30,
2003 2002 2002
----------------- ----------------- -----------------
-------------------------------------------------------
(in thousands)
Balance, Beginning of Period $ 5,449 $ 4,497 $ 4,497
Add:
Provisions charged to operation 1,830 3,001 2,204
Sale of indirect auto loans - (235) (235)
Recoveries 320 179 104
Less: loans charged off 1,851 1,993 1,686
----------------- ----------------- -----------------
Balance, End of Period $ 5,748 $ 5,449 $ 4,884
================= ================= =================
6. ASSET SECURITIZATION
In June 2002, the Bank sold $50.0 million in automobile loan receivables through a securitization transaction. In the transaction, automobile loan receivables were transferred to an independent trust (the “Trust”) that issued certificates representing ownership interests in the Trust, primarily to institutional investors. Although the Bank continues to service the underlying accounts and maintain the customer relationships, this transaction is treated as a sale for financial reporting purposes to the extent of the investors’ interest in the Trust. Accordingly, the receivables associated with the investors’ interests are not reflected on the Statement of Financial Condition. In connection with this transaction, the Bank enhanced the credit protection of the certificateholders by funding a cash reserve account.
In connection with this June 2002 transaction, the Bank originally recorded a pre-tax gain on the sale of automobile loans of $854,000, which was included in gain on sale of loans in the consolidated statement of operations. In July 2003, the Company discovered that computer coding errors related to the indirect automobile loan portfolio also impacted the original gains related to this securitization. As such, the Company has retroactively adjusted the original gain, as well as several key assumptions, to collectively reflect a pre-tax gain of $406,000. The Bank has recognized a retained interest related to the loan sale, which, in aggregate, totaled $3.0 million at June 30, 2003. The retained interest includes an interest-only strip and cash reserve account. The cash reserve account is subject to liens by the providers of the credit enhancement facilities for the securitizations.
The key assumptions used in measuring the fair value of the retained interest-only strip and cash collateral account for the transaction is shown in the following table:
June 30, June 30,
2003 2002
As Restated
----------------- -----------------
Retained interest
Average annual repayment rate 1.5 % 1.5 %
Average annual expected default rate 1.5 1.5
Discount rate 10.0 10.0
Weighted average remaining life of underlying automobile loans
(in months) 37 48
The key economic assumptions and the sensitivity of the fair value of the retained interest asset to an immediate adverse change of 10% and 20% to those assumptions are as follows for the period indicated:
June 30, 2003
-------------
(dollars in thousands)
Fair value of retained interest $ 3,083
Weighted-average repayment rate assumption:
Pre-tax decrease to fair value due to a 10% adverse change $ 44
Pre-tax decrease to fair value due to a 20% adverse change $ 83
Weighted-average expected default rate:
Pre-tax decrease to fair value due to a 10% adverse change $ 44
Pre-tax decrease to fair value due to a 20% adverse change $ 87
Weighted-average discount rate:
Pre-tax decrease to fair value due to a 10% adverse change $ 31
Pre-tax decrease to fair value due to a 20% adverse change $ 62
As of June 30, 2003, the weighted-average remaining life of the underlying automobile loans in the Trust was 37 months. The terms of the transaction included provisions related to the performance of the underlying receivables and other specific conditions that could result in an early payout of invested amounts to the certificateholders.
6. ASSET SECURITIZATION (Continued)
Changes in fair value based on a 10% adverse variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of an adverse variation on a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. However, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.
7. DEPOSITS
Deposits consist of the following major classifications:
June 30, 2003 September 30, 2002
------------------------------------- ------------------------------------
Percent Percent
Amount of Total Amount of Total
----------------- ------------------ ----------------- -----------------
(in thousands)
Noninterest-bearing $ 34,668 5.99% $ 32,428 5.35%
----------------- ------------------ ----------------- -----------------
----------------- ------------------ ----------------- -----------------
Interest-bearing:
Savings 99,878 17.26 95,779 15.78
NOW accounts 93,266 16.11 78,684 12.98
Money market 103,333 17.85 100,274 16.54
----------------- ------------------ ----------------- -----------------
296,477 51.22 274,737 45.30
----------------- ------------------ ----------------- -----------------
Certificates of deposit greater
than $100,000: 45,679 7.90 71,379 11.77
Certificates of deposit less
than $100,000: 201,941 34.89 227,868 37.58
----------------- ------------------ ----------------- -----------------
247,620 42.79 299,247 49.35
----------------- ------------------ ----------------- -----------------
Total $ 578,765 100.00% $ 606,412 100.00%
================= ================== ================= =================
8. FEDERAL HOME LOAN BANK ADVANCES
Under terms of its collateral agreement with the Federal Home Loan Bank of Pittsburgh (“FHLB”), the Bank maintains otherwise unencumbered qualifying assets (principally one-to four-family residential mortgage loans and U.S. Government and Agency notes and bonds) in the amount of at least as much as its advances from the FHLB. The Bank’s FHLB stock is also pledged to secure these advances. At June 30, 2003 and September 30, 2002, such advances mature as follows:
June 30,
Weighted 2003
Due by June 30, Average Rate (in thousands)
----------------------------- ----------------- -----------------
2004 5.60 % $ 59,000
2005 6.34 52,000
2006 5.33 42,000
2007 5.05 5,086
2008 - -
Thereafter 5.29 50,320
----------------- -----------------
Total FHLB advances 5.64 % $ 208,406
================= =================
September 30,
Weighted 2002
Due by September 30, Average Rate (in thousands)
----------------------------- ----------------- -----------------
2003 - % $ -
2004 5.60 59,000
2005 6.34 52,000
2006 5.33 42,000
2007 5.05 5,089
Thereafter 5.29 50,332
----------------- -----------------
Total FHLB advances 5.64 % $ 208,421
================= =================
9. TRUST PREFERRED SECURITIES
On March 25, 2002, the Company sponsored the creation of NEP Capital Trust I, a Delaware statutory business trust. The Company is the owner of all of the common securities of the Trust. On April 10, 2002, the Trust issued $7.0 million of floating rate capital securities through a pooled trust preferred securities offering. The proceeds from this issuance, along with the Company’s $217,000 payment for the Trust’s common securities, were used to acquire $7.2 million aggregate principal amount of the Company’s floating rate junior subordinated deferrable interest debentures due April 22, 2032 (the “Debentures”), which constitute the sole asset of the Trust. The interest rate on the Debentures and the distribution rate on the capital securities are variable and adjust semi-annually at 3.70% over the six-month LIBOR, with an initial rate of 6.02%. A rate cap of 11% is effective through April 11, 2007. The Company has, through the Trust agreement establishing the Trust, a Guarantee Agreement, the Debentures and the related Indenture, taken together, fully irrevocably and unconditionally guaranteed all of the trust’s obligations under the capital securities.
The stated maturity of the Debentures is April 22, 2032. In addition, the Debentures are subject to redemption at par at the option of the Company, subject to prior regulatory approval, in whole or in part on any interest payment date after April 22, 2007. The Debentures are also subject to redemption prior to April 22, 2007 after the occurrence of certain events that would either have a negative tax effect on the Trust or the Company or would result in the trust being treated as an investment company that is required to be registered under the Investment Company Act of 1940. Upon repayment of the Debentures at their stated maturity or following their redemption, the Trust will use the proceeds of such repayment to redeem an equivalent amount of outstanding trust preferred securities and trust common securities.
9. TRUST PREFERRED SECURITIES (Continued)
The Company has the right, at one or more times, to defer interest payments on the Debentures for up to ten consecutive semi-annual periods. All deferrals will end on an interest payments date and will not extend beyond April 22, 2032, the stated maturity date of the Debentures. If the Company defers interest payments on the Debentures, the Trust will also defer distributions on the capital securities. During any deferral period, each installment of interest that would otherwise have been due and payable will bear additional interest (to the extent payment of such interest would be legally enforceable) at the applicable distribution rate, compounded quarterly. Furthermore in 2002, the Company recognized an amortizable intangible asset with a value of $220,000 relating to the issuance costs of these trust preferred securities.
On October 15, 2002, the Company sponsored the creation of NEP Capital Trust II, a Delaware statutory business trust. The Company is the owner of all of the common securities of the Trust. On October 29, 2002, the Trust issued $15.0 million in the form of floating rate capital securities through a pooled trust preferred securities offering. The proceeds from this issuance, along with the Company’s $464,000 payment for the Trust’s common securities, were used to acquire $15.5 million aggregate principal amount of the Company’s floating rate junior subordinated deferrable interest debentures due November 7, 2032 (the “Debentures”), which constitute the sole asset of the Trust. The interest rate on the Debentures and the distribution rate on the capital securities are variable and adjust quarterly at 3.45% over the three-month LIBOR, with an initial rate of 5.27%. A rate cap of 12.5% is effective through November 7, 2007. The Company has, through the Trust agreement establishing the Trust, a Guarantee Agreement, the Debentures and the related Indenture, taken together, fully irrevocably and unconditionally guaranteed all of the trust’s obligations under the capital securities.
The stated maturity of the Debentures is November 7, 2032. In addition, the Debentures are subject to redemption at par at the option of the Company, subject to prior regulatory approval, in whole or in part on any interest payment date after August 7, 2007. The Debentures are also subject to redemption after the occurrence of certain events that would either have a negative tax effect on the Trust or the Company would result in the trust being treated as an investment company that is required to be registered under the Investment Company Act of 1940. Upon repayment of the Debentures at their stated maturity or following their redemption, the Trust will use the proceeds of such repayment to redeem an equivalent amount of outstanding trust preferred securities and trust common securities.
The Company has the right, at one or more times, to defer interest payments on the Debentures for up to twenty consecutive quarterly periods. All deferrals will end on an interest payment date and will not extend beyond November 7, 2032, the stated maturity date of the Debentures. If the Company defers interest payments on the Debentures, the Trust will also defer distributions on the capital securities. During any deferral period, each installment of interest that would otherwise have been due and payable will bear additional interest (to the extent payment of such interest would be legally enforceable) at the applicable distribution rate, compounded quarterly. The Company recognized an amortizable intangible asset with a value of $450,000 relating to the issuance costs of these trust preferred securities.
A summary of the trust securities issued and outstanding at June 30, 2003 is as follows:
Amount
Outstanding at Prepayment Distribution
June 30, Option Payment
Name 2003 Rate Date Maturity Frequency
- ------------------------- ----------------- --------- ----------------- ----------------- -----------------
NEP Capital Trust I $ 7,000,000 5.32% 4/22/2007 4/22/2032 Semi-annually
NEP Capital Trust II $ 15,000,000 4.79% 8/7/2007 11/7/2032 Quarterly
10. GOODWILL AND OTHER INTANGIBLE ASSETS
A summary of goodwill and other intangible assets is as follows:
At June 30, 2003
-----------------------------------------------------------
Gross Net
Carrying Accumulated Carrying
Goodwill Amount Amortization Amount
---------------------------------- -----------------------------------------------------------
(in thousands)
Acquisition of:
Abstractors $ 248 $ (160) $ 88
Security Savings Association of Hazleton 571 (28) 543
Higgins Insurance Associates, Inc. 2,919 (95) 2,824
Schuylkill Savings and Loan Association 200 - 200
------------------- ----------------- ------------------
Total goodwill $ 3,938 $ (283) $ 3,655
=================== ================= ==================
Gross Net
Carrying Accumulated Carrying
Other Intangible Assets Amount Amortization Amount
----------------------------------------------------- ------------------- ----------------- ------------------
----------------------------------------------------- -----------------------------------------------------------
(in thousands)
Amortizing:
Omega core deposit intangible $ 1,537 $ (918) $ 619
Security Savings Association of Hazleton
core deposit intangible 9,086 (1,933) 7,153
Schuylkill Savings and Loan Association
core deposit intangible 255 (43) 212
Other intangibles 929 (184) 745
Nonamortizing intangible assets
Other intangible assets 75 - 75
----------------- ----------------- ------------------
Total other intangible assets $ 11,882 $ (3,078) $ 8,804
================= ================= ==================
Nonamortizing intangible assets consist of title plant of $75,000 at June 30, 2003 and 2002.
10. GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)
Amortization expense of other amortizing intangible assets for the three and nine months ended June 30, 2003 and June 30, 2002 is as follows:
For the Three Months Ended For the Nine Months Ended
June 30, June 30,
2003 2002 2003 2002
----------------- ---------------- ----------------- -----------------
--------------------------------------------------------------------------
(Dollars in thousands)
Core deposit intangibles $ 204 $ 230 $ 619 $ 708
Other amortizing intangibles 51 65 153 101
----------------- ---------------- ----------------- -----------------
Total amortizing intangibles $ 255 $ 295 $ 772 $ 809
================= ================ ================= =================
The estimated amortization expense of amortizing intangible assets for each of the five succeeding fiscal years is as follows:
Core Other Total
Deposit Amortizing Amortizing
Intangibles Intangibles Intangibles
----------------- ----------------- -----------------
(in thousands)
Estimated Annual Amortization Expense
-------------------------------------------------------
For the year ended September 30, 2003 $ 849 $ 176 $ 1,025
For the year ended September 30, 2004 750 176 926
For the year ended September 30, 2005 644 176 820
For the year ended September 30, 2006 586 145 731
For the year ended September 30, 2007 558 90 648
Intangible assets acquired during the nine months ended June 30, 2003 are as follows:
Weighted
Average
Amortization
Amount Residual Period
Assigned Value in Years
----------------- ----------------- -----------------
(dollars in thousands)
Other intangibles $ 450 $ - 5
11. IMPAIRMENT LOSS ON EQUITY INVESTMENT
The Company has a $1.5 million equity investment in the convertible prefered stock of a private entity, which makes loans to and provides services to residential construction builders in the Eastern United States. The Company had previously been accounting for such investment on a cost method. During the June 2003 quarter, the Company recognized an impairment loss to write-off its entire $1.5 million investment in this entity since efforts to raise additional equity capital have proven unsuccessful. While this entity and its lending programs continue to operate, the Bank is no longer a lender in such programs. Additionally, no tax benefit has been recognized in the current impairment loss since such loss is a capital loss and is deductible only against other capital gains.
Item 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In addition to historical information, this Form 10-Q includes certain forward-looking statements based on current management expectations. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. The Company intends such forward-looking statements to be covered by the safe harbor provisions of the Private Securities Reform Act of 1995 and is including this statement for purposes of such safe harbor provisions. The Company’s actual results could differ materially from those management expectations. Factors that could cause future results to vary from current management expectations include, but are not limited to, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulations of federal, state and local tax authorities, changes in interest rates, deposit flows, the cost of funds, demand for loan products, demand for financial services, competition, changes in the quality or composition of the Bank’s loan and investment portfolios, changes in accounting principles, policies or guidelines, and other economic, competitive, governmental and technological factors affecting the Company’s operations, markets, products, services and prices. These factors should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. The Company does not undertake – and specifically disclaims any obligation – to publicly revise any forward – looking statements to reflect events or circumstances after the date of the statements to reflect the occurrence of anticipated or unanticipated events. Further description of the risks and uncertainties to the business are included in detail in Section B, Management Strategy, Section C, Critical Accounting Policies, and Section E, Liquidity and Capital Resources.
A. General
The Company’s results of operations are dependent primarily on the results of operation of the Bank and thus are dependent to a significant extent on net interest income, which is the difference between the income earned on its loan and investment portfolios and its cost of funds, consisting of the interest paid on deposits and borrowings. However, non-interest income has become a meaningful component of the Company’s operations mainly due to fees earned by non-bank subsidiaries. Results of operations are also affected by the Company’s provision for loan losses, loan and security sales activities, service charges and other fee income, and non-interest expense. The Company’s non-interest expense principally consists of compensation and employee benefits, office occupancy and equipment expense, data processing, professional fees, and advertising and business promotion expenses. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities.
The Company’s results of operations are being restated for the fiscal years 1998 through 2002 and for the December 2002 and March 2003 quarters to reflect the correction of accounting errors primarily related to the Company’s indirect auto, mortgage and consumer loan portfolios. The net effect of such restatements was to reduce interest income and retained earnings for prior periods. See Footnote 1 to the unaudited Consolidated Financial Statements for a description of the effect during the periods presented in the Company’s current report on Form 10-Q.
On January 2, 2002, the Company purchased three banking offices from Schuylkill Savings and Loan Association of Schuylkill Haven, Pa. The Company purchased $11.4 million of loans and assumed $12.8 million of deposits from these offices. On January 8, 2002, Higgins acquired the DeAndrea Agency, which specializes in personal and commercial insurance.
On September 4, 2002, the Bank formed a relationship with Smith Barney under which Smith Barney Investment Centers provides retail brokerage products and services at all of the First Federal offices. This is Smith Barney’s first relationship with a bank in the Commonwealth of Pennsylvania. Smith Barney, an independent, registered broker-dealer, is not affiliated with the Bank.
B. Management Strategy
The Company’s operating strategy is that of a community-based financial services company, offering a wide variety of financial products to its retail customers, while concentrating on residential and consumer lending and, to a lesser extent, multi-family and commercial real estate lending, construction lending and small business and municipal commercial lending. In order to promote long-term financial strength and profitability, the Company has focused on: (i) maintaining strong asset quality by originating one- to four-family loans located in its market area; (ii) emphasizing higher yielding consumer loans, specifically indirect automobile loans, and commercial loans, primarily to small businesses and municipalities; (iii) managing its interest rate risk by emphasizing shorter-term, fixed-rate, one- to four-family loans, in addition to consumer and commercial loans; limiting its retention of newly originated longer-term fixed-rate one- to four-family loans; soliciting longer-
term deposits; utilizing longer-term advances from the Federal Home Loan Bank of Pittsburgh (the “FHLB”) and proceeds from the issuance of Trust Preferred securities; and investing in investment and mortgage-related securities having shorter estimated durations; (iv) meeting the financial needs of its customers through expanded products, such as personal and business insurance from Higgins, trust and investment management services from the Trust Co., title insurance from Abstractors, Inc., all with improved delivery systems through technological advances and integration of products; and (v) maintaining a strong regulatory capital position.
As a result of its policy to limit its retention of newly originated longer-term, fixed-rate one- to four-family loans to 25% of total loan originations during a fiscal year, and in light of the low interest rate environment, the Company is selling conforming mortgage loan originations with interest rate adjustments of fifteen years or greater. These loan products are sold at origination in the secondary market.
C. Critical Accounting Policies
Other Investment. The Company has a $1.5 million equity investment in the convertible preferred stock of a private entity, which makes loans to and provides services to residential construction builders in the Eastern United States. The Company had previously been accounting for such investment on a cost method. During the June 2003 quarter, the Company recognized an impairment loss to write-off its entire $1.5 million investment in this entity since efforts to raise additional equity capital have proven unsuccessful. While this entity and its lending programs continue to operate, the Bank is no longer a lender in such programs. Additionally, no tax benefit has been recognized in the current impairment loss since such loss is a capital loss and is deductible only against other capital gains.
Allowances for Loan Losses. The allowance for loan losses is maintained at a level representing management’s best estimate of known and inherent losses in the portfolio, based upon management’s evaluation of the portfolio’s collectibility. Management’s evaluation is based upon an analysis of the portfolio, past loss experience, current economic conditions and other relevant factors. While management uses the best information available to make evaluations, such evaluations are highly subjective, and future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for losses on loans. Such agencies may require the Company to recognize additions to the allowance. The allowance is increased by the provision for loan losses, which is charged to operations. Loan losses are charged directly against the allowance, and recoveries on previously charged-off loans are added to the allowance.
Loans are deemed to be “impaired” if upon management’s assessment of the relevant facts and circumstances, it is probable that the Company will be unable to collect all proceeds due according to the contractual terms of the loan agreement. For purposes of applying the measurement criteria for impaired loans, the Company excludes large groups of smaller balance homogeneous loans, primarily consisting of residential real estate and consumer loans, as well as commercial loans with balances of less than $100,000. The uncollected portion of impaired loans are charged off when the Company determines that foreclosure is probable, and the fair value of the collateral is less than the recorded investment of the impaired loan or in the case of unsecured loans that management determines the loan to be uncollectable.
Intangible Assets. Intangible assets include core deposit intangibles and certain other miscellaneous intangibles. The core deposit intangibles are being amortized to expense over a 10 to 31-year life on an accelerated basis and other intangible assets are being amortized to expense on an accelerated basis over a period of 3.7 to 5 years. The recoverability of the carrying value of intangible assets is evaluated on an ongoing basis, and permanent declines in value, if any, are charged to expense.
Goodwill.Goodwill is the excess of cost over the fair value of assets acquired in connection with business acquisitions and was being amortized on the straight-line method over 5, 6 and 20 years, prior to October 1, 2001. On October 1, 2001, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, which eliminated the regularly scheduled amortization of goodwill and replaced this method with a two-step process for testing the impairment of goodwill on at least an annual basis and to the extent goodwill is impaired, its carrying value will be written down and a charge will be made to earnings. This approach could cause more volatility in the Company's reported net income because impairment losses, if any, could occur irregularly and in varying amounts. The Company, upon adoption of this Statement, stopped amortizing existing goodwill of $3.0 million. In addition, the Company performed its initial impairment analysis of goodwill and other intangible assets and determined that the estimated fair value exceeded the carrying amount.Income Taxes. The Company accounts for income taxes under the asset/liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established against deferred tax assets when in the judgment of management, it is more likely than not that such deferred tax assets will not become available. Because the judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part go beyond the Company’s control, it is at least reasonably possible that management’s judgment about the need for a valuation allowance for deferred taxes could change in the near term.
D. Nonperforming Assets and Impaired Loans
The following table presents information regarding the Bank’s nonperforming loans, real estate owned and other repossessed assets at the dates indicated (unaudited):
June 30, September 30,
2003 2002
----------------- -----------------
-------------------------------------
(dollars in thousands)
Nonperforming loans:
Nonaccrual loans $ 6,270 $ 4,200
Real estate owned and other repossessed assets 641 547
----------------- -----------------
Total nonperforming assets 6,911 4,747
Troubled debt restructurings - 55
----------------- -----------------
Troubled debt restructurings and total nonperforming assets $ 6,911 $ 4,802
================= =================
Total nonperforming loans as a percentage of total loans 1.26 % 0.85 %
Total nonperforming assets as a percentage of total assets 0.78 0.53
The increase in nonperforming assets was primarily due to the addition of a $1.7 million commercial loan. Such loan was placed on nonaccrual status when the borrower filed bankruptcy during 2003. The Bank has previously written-off $100,000 of this loan, established additional reserves and believes this loan is adequately collateralized by the U.S. Department of Agriculture and other collateral.
E. Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations. The Bank further defines liquidity as the ability to respond to deposit outflows as well as maintain flexibility to take advantage of lending and investment opportunities. The Bank’s primary sources of funds are deposits, principal and interest payments on loans, sales and maturities of mortgage-backed and investment securities, and FHLB advances. The Bank uses the funds generated to support its lending and investment activities as well as any other demands for liquidity such as deposit outflows. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows, mortgage prepayments and the exercise of call features are greatly influenced by general interest rates, economic conditions and competition.
The Bank’s most liquid assets are cash and cash equivalents and its investment and mortgage-related securities available-for-sale. The levels of these assets are dependent on the Bank’s operating, financing, lending and investing activities during any given period. At June 30, 2003, cash and cash equivalents and investment and mortgage-related securities available-for-sale totaled $334.7 million, or 37.8% of total assets.
The Bank has other sources of liquidity if a need for additional funds arises, including FHLB advances. At June 30, 2003, the Bank had $208.4 million in advances outstanding from the FHLB under its overall borrowing capacity from the FHLB of $264.4 million. The Bank plans to use the proceeds from the sale of current investments to pay the $59.0 million of fixed-rate FHLB borrowings that will mature within the next twelve months. Depending on market conditions, the pricing of deposit products and FHLB advances, the Bank may continue to rely on FHLB borrowings to fund asset growth. In addition to these traditional funding sources, the Bank may use alternative funding sources, such as the sale and securitization of automobile loans.
At June 30, 2003, the Bank had commitments to originate and purchase loans and unused outstanding lines of credit and undisbursed proceeds of construction mortgages totaling $120.5 million. The Bank anticipates that it will have sufficient funds available to meet these commitments. Certificate accounts, including Individual Retirement Account and KEOGH accounts, which are scheduled to mature in less than one year from June 30, 2003 totaled $89.8 million. Based on past experience, the Bank expects that substantially all of these maturing certificate accounts, with the exception of jumbo certificates of deposit, will be retained by the Bank at maturity. At June 30, 2003, the Bank had $18.0 million in jumbo certificates, the majority of which are deposits from local school districts and municipalities that mature in less than one year.
The primary sources of funding for the Company are dividend payments from the Bank, sales and maturities of investment securities, the issuance of trust-preferred securities and, to a lesser extent, earnings on investments and deposits of the Company. Dividend payments by the Bank have primarily been used to fund the Company’s repurchase of its stock, to pay cash dividends, and to pay interest on the trust-preferred securities. The Bank’s ability to pay dividends and other capital distributions to the Company is generally limited by the regulations of the Office of Thrift Supervision. During April 2002, the Company obtained $7.0 million through a trust-preferred offering, and in October 2002, the Company obtained an additional $15.0 million through a trust-preferred offering. Of the total trust-preferred proceeds, $10.0 million was used to purchase bank-owned life insurance, $5.0 million was used to further capitalize the Bank, and the remaining amount at the Company level was used for general corporate purposes, including to fund the trust established to purchase the Company’s stock, which would be used to satisfy obligations under employee benefit plans. To date, the Company has contributed $1.8 million to the trust, which has used such funds to purchase 114,174 shares of common stock.
At June 30, 2003, the Bank exceeded all of its regulatory capital requirements with a tangible capital level of $57.5 million, or 6.7% of total adjusted assets, which is above the required level of $12.9 million, or 1.5%; a core capital level of $57.5 million, or 6.7% of total adjusted assets, which is above the required level of $25.8 million, or 3.0%; and a risk-based capital of $59.8 million, or 10.5% of risk-weighted assets, which is above the required level of $45.5 million, or 8.0%. An institution with a ratio of tangible capital to total assets of greater than or equal to 5% is considered to be “well-capitalized” pursuant to OTS regulations.
The appropriate balance sheet classification of trust-preferred securities is currently under review pursuant to FIN 46. Although the Federal Reserve Board and other banking regulatory agencies have issued interim guidance that continues to recognize trust-preferred securities as a component of Tier 1 capital, it is possible that a change may result in these securities qualifying for Tier 2 capital rather than Tier 1 capital. If Tier 2 capital treatment had been required at June 30, 2003, the Bank would remain "well capitalized" under applicable federal bank regulatory definitions.
F. Comparison of Financial Condition at June 30, 2003 and September 30, 2002 (As Restated)
Total assets decreased $16.8 million from $902.6 million at September 30, 2002 to $885.8 million at June 30, 2003. The decrease was generated by an $85.3 million sale of mortgage-backed securities, offset by security purchases, loan originations and a $13.4 million increase in cash and cash equivalents. Securities classified as available-for-sale decreased $31.9 million, from $327.9 million at September 30, 2002 to $296.0 million at June 30, 2003. The decrease was attributable to the sale in the March 2003 quarter of $60.3 million of mortgage-backed securities with an average yield of 2.89% and an average life of 1.18 years, with a portion of the proceeds reinvested in securities with average lives of 4.5 years and an average yield of 3.48%. The restructuring continued into the June 2003 quarter with the sale of $25.0 million of mortgage-backed securities. These securities had an average yield of 1.10%, and an average life of .28 years. This restructuring was done to minimize the effect of prepayments of mortgage-backed securities in the lower market interest rate environment.
Net loans increased $4.7 million from September 30, 2002. Consumer loans increased $37.9 million due to a $42.3 million increase in indirect automobile loan originations within the Company’s market area offset by a decrease in other consumer loan balances. Total real estate loans decreased $33.7 million due to a $38.9 million decrease in one- to four-family residential real estate loans primarily the result of prepayments of mortgages due to the lower interest rate environment, offset by a $10.1 million increase in commercial construction loans.
Total liabilities decreased $15.6 million from $836.9 million at September 30, 2002 to $821.3 million at June 30, 2003, due primarily to a $27.6 million decrease in deposits offset by the issuance of $15.0 million in trust-preferred securities.
Deposits decreased $27.6 million from $606.4 million as of September 30, 2002 to $578.8 million at June 30, 2003. The largest decrease was in certificates of deposit, which decreased $51.6 million as a result of matured certificates being rolled into checking and other interest-bearing accounts as well as municipalities and local school districts withdrawing funds for use in operations.
In October 2002, the Company issued $15.0 million of trust-preferred securities. The interest rate on the trust-preferred securities is variable based on three-month LIBOR and adjusts quarterly with a rate as of June 30, 2003 of 4.79%. The trust preferred securities are subject to an interest rate cap of 12.5% through November 7, 2007.
Total equity decreased by $1.2 million primarily due to a $506,000 decrease in accumulated other comprehensive income as a result of a decrease in unrealized gains on securities. Because of interest rate volatility, accumulated other comprehensive income could materially fluctuate from period to period depending on economic and interest rate conditions. Equity also decreased due to the purchase of 69,133 shares for the stock employee compensation trust at a cost of $1.1 million and dividend payments of $1.5 million. These decreases were offset by net income for the nine months of $644,000, the release of shares under the employee stock ownership plan and the vesting of previously granted shares of restricted stock.
G. Comparison of Operating Results for the Three Months ended June 30, 2003 and June 30, 2002 (As Restated)
General. The Company had a net loss of $1.1 million and net income of $944,000 for the three months ended June 30, 2003 and June 30, 2002, respectively. Basic and diluted earnings (loss) per share decreased to $(0.29) and $(0.28) per share, respectively, for the three months ended June 30, 2003 as compared to $0.23 and $0.22 per share, respectively, for the same period in 2002.
Interest Income. Total interest income decreased $2.1 million, or 15.9%, from $13.2 million for the three months ended June 30, 2002 to $11.1 million for the three months ended June 30, 2003. This decrease was primarily due to a 120 basis point decline on the tax-equivalent yield on earning assets to 5.34% for the three months ended June 30, 2003 as compared to 6.54% for the same period ended 2002 due to the lower interest rate environment. Interest income on loans decreased $1.2 million primarily due to a 78 basis point decrease in the yield due to lower rates, combined with an $11.6 million decrease in the average balance of loans. Interest income on mortgage related securities decreased $950,000 as the yield on such securities declined 231 basis points, offset by an increase in the average balance of $13.0 million. Interest income on taxable investment securities increased $50,000 despite a 70 basis point decline. Rapid repayment of mortgage-backed securities has occurred while reinvestment options are at substantially lower rates than the previous year.
Interest Expense. Interest expense decreased $1.1 million, or 15.4%, from $7.2 million for the three months ended June 30, 2002 to $6.1 million for the three months ended June 30, 2003. The decrease in interest expense was primarily attributable to a declining interest rate environment that resulted in the cost of deposits decreasing to 2.08% for the three months ended June 30, 2003 from 3.11% for the same period ended 2002. Offsetting the declining rates was an increase in the average balance of interest-bearing liabilities of $35.0 million to $785.9 million for the three months ended June 30, 2003. The decrease in interest expense on deposits of $1.3 million was primarily due to a $1.2 million decrease in interest expense on certificates of deposit, which was the result of an 89 basis point decrease in interest rates and a $56.1 million decrease in the average balance, offset by a $70.9 million increase in the average balance on checking accounts. Interest expense on trust-preferred debt increased $171,000 due to the issuance of $15.0 million trust-preferred securities in October 2002.
Provision for Loan Losses. The provision for loan losses increases the allowance for loan losses. The Bank’s provision for loan losses for the three months ended June 30, 2003 increased $124,000 compared to the comparable 2002 period. The increase was due to increased mortgage and consumer charge offs and an increase in nonperforming loans and classified assets. During the preceding quarter, the Company enhanced its loan servicing function to promote the prompt resolution of delinquencies and employed a new collections and recovery manager to address the risk of deterioration in loan quality. As a result, total delinquencies for mortgage and consumer loans were reduced during the quarter to 0.73% and 0.28% of total loans, respectively, at June 30, 2003, from 1.13% and 0.40% at June 30, 2002. Net loan charge-offs of $672,000 for the quarter ended June 30, 2003, compared to net loan charge-offs of $879,000 for the quarter ended June 30, 2002. Net loan charge-offs, as a percentage of total loans for the current quarter, were 13 basis points. At June 30, 2003, delinquent commercial loans were 0.81% of total loans, an increase from the 0.48% level at June 30, 2002, due to a $1.7 million commercial loan being placed on nonaccrual as the borrower went into bankruptcy.
Non-interest Income. Non-interest income decreased $521,000, or 23.3% from $2.2 million for the three months ended June 30, 2002 to $1.7 million for the three months ended June 30, 2003. Other income for the three months ended June 30, 2003 decreased $1.4 million due to the recognition of the $1.5 million impairment loss for the Company’s equity investment in the convertible preferred stock of a start-up mortgage banking firm specializing in multi-state, small builder loans. Insurance commission income increased $262,000, due to continued growth in insurance related services. Service charges and other fees increased $185,000 due to a larger customer base. Gain on sale of available-for-sale securities increased $233,000 due primarily to the gain on the sale of $25.0 million in mortgage-backed securities as part of the restructuring of the investment portfolio.
Non-interest Expense. Total non-interest expense increased $801,000, or 13.3%, from $6.0 million for the three months ended June 30, 2002 to $6.8 million for the three months ended June 30, 2003. This increase was due primarily to an increase in salaries and benefits of $492,000 due to the increased cost of employee benefits and new employees to staff expanding lines of business.
Other non-interest expense increased $306,000 due to one of the Bank’s commercial loan customer that had significant cash flow difficulty during the quarter which required the Bank to provide cash flow and other support. The expenses associated with the workout of this loan totaled $156,000. In late March 2003, the Bank decided to close three retail offices, sell the buildings occupied by two of these offices and reduce the office hours at a fourth office. These actions are expected to result in savings of $330,000 per year beginning with the fourth fiscal quarter of 2003. Deposit services will be provided by nearby First Federal offices. The Company recognized a $108,000 impairment loss in connection with the closure of these offices. Non-interest expense also increased due to costs associated with foreclosed properties combined with general increases in operating expenses such as supplies and telephone and other incremental increases that resulted from operating a larger organization. Installation of a new telephone system was completed in the Hazleton offices in June 2003 with the remaining office installations to be completed by September 30, 2003. The new system is expected to reduce annual long distance telephone costs by approximately $125,000 by transmitting over inter-office data lines. Advertising costs increased $90,000 over the previous year quarter as the Company continued the promotion of a new branding campaign. Occupancy expenses increased $45,000 due to seasonal operating expenses such as utilities and maintenance. The increase in non-interest expense was offset by an $89,000 decrease in professional fees due to prior year quarter engagement of consultants to assist in the continuation of a branding campaign to integrate all lines of business.
Income Taxes. The Company had an income tax provision of $125,000 for the three months ended June 30, 2003, compared to a provision of $498,000 for the three months ended June 30, 2002, resulting in effective tax rates of (12.8)%, and 34.5%, respectively. This decrease was due to a decrease in income before taxes, offset by an increase to a deferred tax asset valuation allowance related to the Company’s ability to use a charitable contribution carryforward. Although the Company reported a pre-tax loss for the June 2003 quarter, the Company still provided for income taxes due to no tax benefit being provided on the $1.5 million impairment loss the Company recognized. Such loss is a capital loss for federal income tax purposes which can only be used to offset capital gain income is not expected to result in a tax deduction for the Company.
H. Comparison of Operating Results for the Nine Months ended June 30, 2003 and June 30, 2002 (As Restated)
General. The Company had net income of approximately $644,000 and $3.0 million for the nine months ended June 30, 2003 and June 30, 2002, respectively. Basic and diluted earnings per share were $0.17 and $0.16 per share, respectively, for the nine months ended June 30, 2003 and $0.73 and $0.69, respectively, for the nine months ended June 30, 2002.
Interest Income. Total interest income decreased $5.2 million, or 13.0%, from $40.0 million for the nine months ended June 30, 2002 to $34.8 million for the nine months ended June 30, 2003. This decrease was primarily due to a 124 basis point decline on the tax-equivalent yield on earning assets to 5.53% for the nine months ended June 30, 2003 as compared to 6.77% for the same period ended 2002 due to lower rates. Interest income on loans decreased $3.3 million primarily due to a 78 basis point decrease in the yield. Interest income on mortgage-related securities decreased $1.1 million as the yield on such securities declined 182 basis points, offset by an increase in average balance of $46.6 million. Rapid repayment of mortgage-backed securities has occurred while reinvestment options are at substantially lower rates than the previous year. Interest income on taxable investment securities decreased $784,000 as a result of a 141 basis point decline.
Interest Expense. Interest expense decreased $2.2 million, or 10.2%, from $21.7 million for the nine months ended June 30, 2002 to $19.5 million for the nine months ended June 30, 2003. The decrease in interest expense was primarily attributable to a declining interest rate environment that resulted in the cost of deposits decreasing to 2.31% for the nine months ended June 30, 2003 as compared to 3.30% for the same period in 2002. Offsetting the declining rates was an increase in the average balance of interest-bearing liabilities of $65.4 million to $795.9 million for the nine months ended June 30, 2003. In particular, the average balance of interest-bearing transaction accounts increased $77.2 million to $200.0 million. This increase was the result of the competitively priced products being marketed throughout the Company’s market area. The decrease in interest expense on deposits of $3.0 million was primarily due to a $3.3 million decrease in interest expense on certificates of deposit, which was the result of a 103 basis point decrease in interest rates. Interest expense on trust-preferred debt increased $688,000 as a result of the issuance of $15.0 million trust-preferred securities in October 2002.
Provision for Loan Losses. The Company’s provision for loan losses for the nine months ended June 30, 2003 decreased $139,000 compared to the comparable 2002 period. Nonperforming assets at June 30, 2003 were $6.9 million, or 0.78% of total assets, from $4.9 million, or 0.57% of total assets as of June 30, 2002. The Company enhanced its loan servicing function to promote the prompt resolution of delinquencies and employed a new collections and recovery manager to address the risk of deterioration in loan quality. As a result, total delinquencies for mortgage and consumer loans were reduced to 0.73% and 0.28% of total loans, respectively, at June 30, 2003, from 1.13% and 0.40% at June 30, 2002. The Bank also completed a full review of its mortgage and consumer loan portfolios and charged-off loans where the fair value of assets fell below the book
value. This analysis led to net loan charge-offs of $1.2 million for the nine months ended June 30, 2003, compared to net loan charge-offs of $702,000 for the nine months ended June 30, 2002. Net loan charge-offs, as a percentage of total loans for the fiscal year-to-date were 31 basis points. At June 30, 2003, delinquent commercial loans were 0.81% of total loans, an increase from the 0.48% level at June 30, 2002.
Non-Interest Income. Non-interest income increased $2.6 million, or 48.7%, from $5.4 million for the nine months ended June 30, 2002 to $8.1 million for the nine months ended June 30, 2003. During the nine months ended June 30, 2003 there was an $85.3 million sale of mortgage-backed securities, which resulted in gains on sale of securities of $1.4 million. Insurance commission income increased $647,000 due to continued growth in insurance related services. Service charges and other fees increased $456,000 due to a larger customer base. Gain-on-sale of loans increased $417,000 as $35.1 million of originations of fixed-rate mortgages, in excess of the Bank’s retention policy, were sold in the nine months ended June 30, 2003 compared to $10.6 million of such loans sold in the same period in 2002. Other income decreased $572,000 due to the recognition of the $1.5 million impairment loss for an equity investment, offset by a $564,000 increase in income associated with the prior year sale and securitization of $50.0 million of automobile loans and $356,000 of income on bank-owned life insurance.
Non-interest Expense. Total non-interest expense increased $2.8 million, or 16.5%, from $17.1 million for the nine months ended June 30, 2002 to $19.9 million for the nine months ended June 30, 2003. This increase was due primarily to an increase in compensation and employee benefits of $1.1 million for increased benefit costs and new employees to staff the growth in the Company’s business lines. Other non-interest expense increased $864,000 due to the $156,000 expense of providing cash flow support to a commercial loan customer who had significant cash flow difficulty. Other non-interest income increased due to an impairment loss in connection with the closure of three bank offices as well as costs associated with foreclosed properties combined with general increases in operating expenses such as supplies and telephone and other incremental increases that resulted from operating a larger organization. Advertising costs increased to $345,000 over the previous year quarter as the Company continued the promotion of a new branding campaign. Occupancy expenses increased $284,000 period over period due to Company expansion. Professional fees increased $192,000 as a result of increased accounting fees coupled with an increase in consulting services during the transition between chief financial officers.
Income Taxes. The Company had an income tax provision of $967,000 for the nine months ended June 30, 2003, compared to a provision of $1.6 million for the nine months ended June 30, 2002 resulting in effective tax rates of 60.0%, and 34.8%, respectively. The decline in income tax expense was primarily attributable to a decrease in taxable income, offset by the increase in taxes as a result of an increase in a deferred tax asset valuation allowance related to the Company’s ability to use a charitable contribution carryforward. The large increase in the effective tax rate during the nine month period ended June 30, 2003 was due to the $1.5 million impairment loss the Company recognized. Such loss is a capital loss for federal income tax purposes which can only be used to offset capital gain income. Such loss is not expected to result in a tax deduction for the Company.
| Item 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
| As of June 30, 2003, there have been no material changes in the quantative and qualitative disclosures about market risks presented in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002. | |
| Item 4. | CONTROLS AND PROCEDURES |
| (a)Evaluation of disclosure controls and procedures: The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon her evaluation of those controls and procedures performed at June 30, 2003, the chief executive officer and the chief financial officer of the Company concluded that the Company’s disclosure controls and procedures were not effective, as further described below. | |
| During the preparation and review of this Form 10-Q Quarterly Report, the Registrant discovered that its financial statements for its fiscal years 1998 through 2002 and for the December 2002 and March 2003 quarters required restatement as discussed under Management's Discussion and Analysis and Note 1 to the Financial Statements included in this Quarterly Report. The Company believes that it maintained effective controls and procedures designed to ensure that information required to be disclosed in its reports filed under the Securities Exchange Act of 1934 with respect to those prior periods, except that the individuals responsible for implementing such controls and procedures, including reviewing the work performed and authorizing the final results, failed to detect certain errors, including a computer coding error related to the Company's indirect automobile loan portfolio, which required the restatement. Subsequent to the discovery of the errors, Management has implemented staffing, system and procedural changes designed to improve the training of the individuals involved in implementing and reviewing the controls and procedures to strengthen the review and authorization process so that such errors do not occur in the future. The Chief Executive Officer and Chief Financial Officer believes that the corrective actions taken should be adequate to remedy the aforementioned control inadequacies. | |
| (b)Changes in internal controls.The Company made no significant changes in its internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation of those controls by the chief executive officer, except for the corrective actions referred to in item (a) above. |
Part II - OTHER INFORMATION
| Item 1. | Legal Proceedings |
| The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the Company’s financial condition or results of operation. | |
| Item 2. | Changes in Securities and Use of Proceeds |
| Not applicable. | |
| Item 3. | Defaults Upon Senior Securities |
| Not applicable. | |
| Item 4. | Other information |
| Not applicable. | |
| Item 5. | Exhibits and Reports on Form 8-K |
| (A) | Exhibits |
| 3.1 | Certificate of Incorporation of Northeast Pennsylvania Financial Corp.* |
| 3.2 | Bylaws of Northeast Pennsylvania Financial Corp.** |
| 4.0 | Form of Stock Certificate of Northeast Pennsylvania Financial Corp.* |
| 11.0 | Statement regarding Computation of Per Share Earnings (See Notes to Consolidated Financial Statements) |
| 31.1 | Rule 13a-14(a)/15d-14(a) Certification |
| 32.0 | Section 1350 Certification |
| * | Incorporated herein by reference into this document from the Exhibits to Form S-1, Registration Statement, and any amendments thereto, Registration No. 333-43281. |
| ** | Incorporated herein by reference into this document from the Exhibits to the Form 10-K/A as filed with the Securities and Exchange Commission on January 8, 2003. |
| (B) | Reports on Form 8-K |
| On April 25, 2003, the Company filed a Form 8-K in which it announced its financial results for the quarter ended March 31, 2003. A press release announcing the financial results was filed by exhibit. |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| NORTHEAST PENNSYLVANIA FINANCIAL CORP. |
|
| Date: August 19, 2003 | By: /s/ E. Lee Beard E. Lee Beard President, Chief Executive Officer, and chief financial officer |